When the economy reopens, what will the recovery look like?
Every economist is struggling with that question. The timing of the reopening will greatly affect the shape of the upturn. And the strength of the expansion will depend upon business and consumer behavior, government finances, and a global recovery. There are lots of variables, but not a lot of certainty.
First, keep one thing in mind: The actions taken by Congress and the Federal Reserve are stabilization programs, not stimulus plans. You have to stop falling before you can start rising again.
The Fed flooded the financial markets with massive amounts of liquidity. But while those actions created financial market stability, they do not insure growth will take place.
Similarly, the CARES Act may create a temporary lifeboat for many businesses and households, but when funds begin to run out, they will have to stand on their own.
The CARES Act also has some time-limited elements to it. For many, there are one-time grants of $1,200, plus up to $1,000 for children. But those grants will not be repeated.
There is a major boost to unemployment insurance payments of $600 per week, on top of regular state payments. But those last for four months.
And the extra unemployment payments come with unintended consequences. While state payments vary, the average is roughly $350 per week. When you add $600 to that, the total is large enough that many low- and moderate-income workers would have an incentive to remain on the unemployment rolls rather than accept job offers.
The CARES Act also changes the way government funds are distributed to “unemployed” workers. Instead of laid-off workers receiving unemployment compensation, the government funds the wages of small to mid-size business who hire back workers. Those “workers” shift from being unemployed to being employed, even though the true “employer” paying the salary is the government.
The idea is to create a Reserve Army of the Employed. Whether they actually work is irrelevant. As long as firms meet certain rehiring and retention requirements, the “loan” becomes a “grant” – it’s free money for salaries and other costs such as rent.
But that money does run out and firms will have to start acting like private-sector companies, not wards of the state. That means they have to “make money the old-fashioned way: They have to earn it”. When that time comes, the economy matters most.
Despite all the money flowing from all the government funding plans, the best they can do is stop the decline. Turning it around will require the economy reopening — and probably a lot more government money.
And, that brings us to the shape of the recovery.
The standard view is that we will have a “V”-shaped recovery. We crashed and burned, but once the economy reopens, it will rebound sharply. Indeed, as the argument goes, given the trillions of dollars being poured into the economy, a massive rebound is likely.
At least in the first couple of months, that could happen. Since enormous numbers of firms closed, their reopening will obviously create an initial surge in activity. Households will likely go on a spending binge, restocking their homes and satisfying pent-up demand for all sorts of things.
Unfortunately, to keep growth going, everything must go right:
The V-recovery requires the pandemic end fairly quickly and at about the same time across the country. An extended shutdown increases damage greatly and reduces business survival rates. An in-sync recovery is needed to create the momentum required for strong growth.
Households will have to become exuberant almost immediately and businesses will have to rehire most of their laid-off workers, keep them on the payrolls, and start investing right away.
And most important, there cannot be a resurgence in the virus that leads to another shutdown. If that happens, the money spent will be largely wasted.
There are simply too many significant conditions that must be met for the V-recovery to happen.
More likely, the initial sharp rise in growth will wind up being a head fake, once the exuberance wears off. The six to 12 months after the initial upturn may be the most critical. That is when the economic fundamentals take over.
On the consumer side, income matters the most. Initially, the government is supporting millions of workers. But once those payments decline, demand will have to be strong enough so businesses can pay those workers.
But consumers might not start shopping till they drop. Even after firms start rehiring, the unemployment rate could be in the teens. With so many unemployed, demand will be well below pre-pandemic levels. Thousands of firms will fail, keeping unemployment high for an extended period. It could take years before the unemployment rate reaches 5%, let alone the 3.5% it was in February.
Exacerbating the problem is that hiring is likely to be cautious and only enough to meet the CARES Act requirements. When the loans become grants, firms will be free to cut expenses by reducing head count. Decimated sectors, such as hospitality and travel, may take years to reach previous employment levels.
As for capital spending, companies weren’t investing robustly when the economy was decent and the tax cuts were implemented. Why would they invest in an uncertain environment?
As for government spending, the federal largesse is slated to fade quickly. In addition, state and local government budgets have been decimated, forcing them to tighten belts. Government spending will decline as the recovery kicks in.
And finally, the rest of the world has to chip in. When Europe and Asia will start growing as solidly as they were before COVID-19 hit is anyone’s guess, but there is no reason to believe they will move in lockstep with the United States.
Putting this all together, you get a recovery that starts with a "V" but then moves to “u” with a fairly long bottom. It may take six to 12 months after the initial surge fades for the economy to move back to a sustainable growth pace.